Large Positions

Herschel Walker was a formidable running back in the late 1980s and early 1990s. He was drafted and played the first part of his career at the Dallas Cowboys. He amassed 8,225 rushing yards and scored 61 rushing touchdowns throughout his career. At a time when few running backs were also receivers, he recorded 4,859 receiving yards which contributed to his reputation as a potentially game changing player.

In 1989, the Minnesota Vikings decided they had to have him. They believed he would be the final piece they needed to win a Super Bowl leading them to give up a total of eight draft picks, including three first-round picks and three second-round picks, along with five players.

However, Walker was never able to live up to those expectations in Minnesota and was gone from the team within three seasons.

The Cowboys used the wealth of draft picks they received to build a dynasty in the 1990s. They drafted future Hall of Famers Emmitt Smith and Darren Woodson, as well as several other key contributors to their championship teams. The Cowboys won three Super Bowls with those players in 1992, 1993, and 1995.

Minnesota was thinking about one amazing player. Dallas was thinking about the whole team. The trade became known as “The Great Train Robbery” because of how one-sided the outcome was in Dallas’s favor. It’s used as a prime example of how focusing on a single player rather than the whole team can be a colossal mistake.

At our Summit, Jason Buck told me the story above about Herschel Walker. It got me thinking about position sizing.

When I was a private investor, I was super concentrated in 2-3 stocks. All it took was one or two big winners in any given year to have a phenomenal year which I would define as a portfolio return of 75%+. 

When you own a 2-3-stock portfolio, you have the time to go a mile deep into your positions. This can also become the biggest downside. The downside of super concentration is overthinking your positions. You have too much time to think about a few things. 

As your capital grows it’s important to grow yourself with your capital. It’s a natural progression to add a few more positions. Why? You get better at knowing what you are looking for and waiting until you find it. You also get better at evaluating and tracking more positions than when you were younger. I feel today I can get similar performance out of 4-8 core positions (core = 10%+ positions) with less volatility and risk as I did with 2-3 core positions. 

I started managing outside capital in late 2018. We normally hold 4-8 core positions (85% of portfolio) and another 4-5 smaller/tracking positions. I view our large core positions similar to veteran players on a sports team. Core positions have earned their right to their position size/salary. You've spent considerable time to get to know them. You've witnessed how the management and the business react under pressure. They've proven themselves and have earned your conviction and trust. The stock has rewarded you with good returns and you have rewarded the management/business with a bigger weighting in the portfolio.

For long only quality focused stock pickers, your largest positions should be the businesses you’ve held the longest that have gone up the most. It doesn’t always work out this way but directionally I think the statement is correct. 

Our 4-5 smaller/tracking positions I view as our farm team/minor league team. These businesses have a majority of the elements we seek to make an investment, but they are still somewhat young, immature, and unproven. We buy a little to put them on our team, to follow and get to know the management, and give them a little playing time. The minor league is where a bulk of our turnover occurs. If the management team and business perform, we will buy more and make them a core position. If they don’t perform, we kick them off the team and replace them with other talented prospects.

Building conviction in a position is the same as building trust in a relationship. It just takes time to develop. It can’t be forced. The best relationships are built over time. The best positions are built over time. 

If you are a concentrated investor that lets positions run, the larger a position becomes the more it will lead the entire portfolio up and down. Every stock has its own little bull and bear market cycle going on within its equity independent of the macro cycle. They can last for months, quarters, years, triggered by a really good or bad quarter. Hated to loved, loved to hated. Large positions can make you look like a hero in bad times (outperform during bear markets), and an idiot in good times (underperform during bull markets). 

Earlier this year I had a 30% position that was down 30% YTD, and I had two 5% positions go up 100%, and I remember thinking how hard I had to work to breakeven, but that is the price you pay for concentration. It cuts both ways. I'm used to this, but you must be sure your investors understand.

An imperfect analogy might be the more you pay your superstar player the less you can pay/allocate to the other players. You also must be sure your superstar doesn’t get hurt. If you don’t get production out of your superstar, the rest of the team really needs to step up. 

A few years ago, I had a phenomenal year in the market. I owned 10 stocks and 7 of them returned 100%+ in the same year. I look forward to that happening again – in my lifetime. When I looked at the attribution, I remembered thinking that it now takes a team effort to produce a phenomenal return in the portfolio in a single year. I used to go all in on one superstar, and now I build winning teams.

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